IMPACT OF FDI ON THE ECONOMY OF A COUNTRY


 


How does outward foreign direct investment (FDI) affect domestic economic activity? This question has been the subject of extensive public policy debate in the industrialized world. Opponents of outward FDI argue that outward investment substitutes foreign for domestic production when firms shift parts of the production abroad. Accordingly, outward investment inevitably reduces domestic investment, employment, productivity, and thereby economic growth. Proponents of outward investment, in contrast, point out that outward FDI enables firms to enter new markets, to import intermediate goods from foreign affiliates at lower costs, and to access foreign technology. From this point of view, the entire domestic economy benefits from outward FDI due to the increased competitiveness of the investing companies and associated productivity spillovers to local firms.


            Unfortunately, empirical studies do not provide a clear picture of whether and how domestic economic activity is influenced by outward FDI. Stevens and Lipsey (1992), for example, analyze the domestic investment behavior of seven US multinational companies. Their results suggest that that outward investment and domestic investment are substitutes. Desai et al. (2005), on the other hand, using time-series data for the US firms, find a positive relationship between domestic and foreign investment. This finding, in turn, is consistent with a study by Lipsey (1994), who reports a positive correlation between foreign production and domestic employment levels by the US firms. In contrast, the results by Blomström et al. (1997) suggest that in the US multinational firms, higher foreign production is associated with lower employment at home, whereas Swedish parent companies employ more labor at home when they produce more abroad. Finally, Braconier et al. (2001) examine the related question of whether domestic productivity is affected by outward FDI. Using firm- and industry-level panel data for Sweden, they find no evidence of FDI-induced productivity gains. This, however, is in contrast to the results by Barba Navaretti and Castellani (2004), who find that in Italian firms, outward investment increases domestic output and productivity growth.


Admittedly, a common feature of all these studies is that they are based on firm- or industry-level data for manufacturing. Since, however, services have emerged as the leading industry for outward FDI, the large majority of outward investment is excluded from the analysis a priori. Furthermore, data restricted to individual investing firms or industries are by definition not able to capture the effects of outward investment on the economy as whole. However, resolving the policy debate about the effects of outward FDI on domestic economic activity requires clarifying the overall effects of outward FDI – in particular, the effects of aggregate outward FDI on economic growth.


China has become the top foreign direct investment (FDI) destination among all developing countries and remained host to the world’s largest share of FDI receipts since its accession to the WTO in 2001. Together with the extremely impressive record of FDI influx since China’s economic reform in 1979, Chinahas also experienced remarkable economic growth and development by achieving a high growth rate of almost 10% per annum, on average, and over 10% during the period after Deng’s speech in 1992 reaffirming China’s continuous economic opening. Given such a notable economic growth performance, the quest of China’s sustainable growth continues to stimulate much discussion and vigorous debates among academics during recent years. However, in studying China’s growth, special attention has to be paid to the two major globalized delta economies (GDEs), Pearl River Delta (PRD) and Yangtze River Delta (YRD), located respectively in the south- and east-coastal China (Tuan and Ng, 2009).


China’s economic reform and opening policy launched in 1979 successively made PRD and YRD the two most dynamic regions in China.2 These two GDEs represented the two most dominating, fastest growing regions and continued to out-perform all other regions in China in terms of GDP performance and FDI absorption.3 The PRD and YRD, which together account for only 1.4% of China’s total land area and 7.7% of the total population,4 have contributed (on average) 12.3% and 27.4%, respectively to China’s national GDP in recent years; they absorbed 26.2% and 36.1%, respectively, of the total national inward FDI during the post-reform period. In addition, the GDP growth rates of PRD and YRD reached an average of 13.8% and 11.9%, respectively, during the period from 1979 to 2005, a much higher pace than the national average growth rate of 9.7% during the same period (Tuan and Ng, 2009).


 


References


 


Barba Navaratti, G., Castellani, D. (2004), “Does investing abroad affect performance at home? Comparing Italian multinational and national enterprises”, London, CEPR Working Paper No. 4284,


Blomström, M., Fors, G., Lipsey, R.E. (1997), “Foreign direct investment and employment: home country experience in the United States and Sweden”, Economic Journal, Vol. 107 No.445, pp.1787-97.


Braconier, H., Ekholm, K., Knarvik, K.H.M. (2001), “Does FDI work as a channel for R&D spillovers? Evidence based on Swedish data”, Review of World Economics, Vol. 137 No.4, pp.644-65.


Desai, M.A., Foley, F., Hines, J.R. Jr (2005), “Foreign direct investment and domestic capital stock”, American Economic Review Papers and Proceedings, Vol. 95 No.2, pp.33-8.


Stevens, G.V.G., Lipsey, R.E. (1992), “Interactions between domestic and foreign investment”, Journal of International Money and Finance, Vol. 11 No.1, pp.40-62.


Tuan, C. and Ng, L. (2009). “China’s post-economic reform growth: the role of FDI and productivity progress”. Journal of Asian Economics. 20(3), 280 – 293.


 



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